Chapter 10: Corporate Governance 313
10-1a Agency Relationships
The separation between owners and managers creates an agency relationship. An agency
relationship exists when one or more persons (the principal or principals) hire another
person or persons (the agent or agents) as decision-making specialists to perform a
service.^19 Thus, an agency relationship exists when one party delegates decision-making
responsibility to a second party for compensation (see Figure 10.1).
In addition to shareholders and top-level managers, other examples of agency
relationships are top managers who hire subsidiary managers, client firms engaging
consultants and the insured contracting with an insurer. Moreover, within organiza-
tions, an agency relationship exists between managers and their employees, as well
as between top-level managers and the firm’s owners.^20 However, in this chapter we
focus on the agency relationship between the firm’s owners (the principals) and top-
level managers (the principals’ agents) because these managers are responsible for
formulating and implementing the firm’s strategies, which have major effects on firm
performance.^21
The separation between ownership and managerial control can be problematic.
Research evidence documents a variety of agency problems in the modern corporation.^22
Problems can surface because the principal and the agent have different interests and
goals or because shareholders lack direct control of large publicly traded corporations.
Problems also surface when an agent makes decisions that result in pursuing goals that
conflict with those of the principals. Thus, the separation of ownership and control
potentially allows divergent interests (between principals and agents) to occur, which
can lead to managerial opportunism.
An agency relationship
exists when one party
delegates decision-making
responsibility to a second
party for compensation.
Figure 10.1 An Agency Relationship
Shareholders (Principals)
An Agency Relationship
- Risk-bearing specialist (principal)
paying compensation to
- A managerial decision-making
specialist (agent)
Managers (Agents)
Hire
and create
